Why it’s time for this ugly stepchild commodity’s day in the sun

March 24, 2016 | Kim Iskyan

Oil gets all the headlines. Oil prices are all over the news, wars are fought over it, and you probably use it to fuel your vehicle. But while oil’s energy stepbrother, natural gas, sits in the shade, it might offer more to investors looking to speculate on a commodity.

Like oil, natural gas is a critical ingredient for modern civilization. According to the International Energy Agency, 22 percent of the world’s electricity is generated using natural gas.

In Asia, natural gas isn’t as important for electricity. Only 2 percent of China’s electricity production comes from natural gas. China still relies on coal to supply a massive 76 percent of its electricity. And India uses coal for 60 percent of its electricity, while natural gas only accounts for 9 percent.

Natural gas is also a key ingredient for many useful products, like plastics, fertilizers and fabrics. And because it’s much cleaner than coal, it’s a favoured pollution solution.

Like most other commodities, natural gas prices are close to multi-year lows. On March 3, the price of natural gas fell to US$1.64 per million British thermal units (MMBtu). That was its lowest level since 1998. Since then, it’s up 14 percent, but is still about as cheap as it’s ever been.

Natural gas prices reached an all-time high of US$15.38/MMBtu in 2005, meaning its prices have dropped by almost 90 percent in the past 10 years. This year alone, the price of natural gas is down by more than 20 percent.

Natural gas prices have dropped for the same reason oil prices have – there’s too much of it. The U.S. has recently been able to use new technologies to tap its huge reserves of shale gas, which is natural gas trapped in rocks.

Due in part to these new shale gas supplies, total production in December 2015 hit 2.29 trillion cubic feet, the highest monthly level for December on record, and 5.3 percent above December 2014 production.

There is also a record amount of natural gas being stored for future use – more than 40 percent more than the five-year average amount.

But, like they have with oil, analysts are suggesting the bottom of the natural gas market has been reached, and a rebound is likely for the rest of 2016.

The U.S. Energy Information Administration (EIA) expects natural gas (with a 33 percent share) to overtake coal (32 percent) as the primary source of power generation in the U.S., which is the world’s biggest natural gas consumer, and producer.

The growth in demand for natural gas is also expected to be higher than the growth in supply. The EIA estimates that supply will grow by 0.9 percent this year. Demand is expected to grow by more than 2 percent.

This should lead to a slight rise in natural gas prices, even though there is a lot of gas in storage that needs to be used up first.

The gradual shift from coal to natural gas to generate electricity by U.S. power plants will also support natural gas prices over the long term.

Chemical manufacturers have also begun taking advantage of low U.S. gas prices. The American Chemical Council reported in July 2015 that 238 new chemical manufacturing plants would be built in direct response to low gas prices.

By February 2016, the number had increased to 266, representing US$145 billion in new investment, mostly by foreign companies. This new demand for U.S. gas from chemical manufacturers will help boost demand and drive prices back up.

Gas is also now considered the clean alternative to coal and other fossil fuels. As China and other countries continue implementing cleaner energy standards, natural gas will become more important globally. That will support natural gas prices.

The swelling levels of storage could mean that gas prices might remain low for some time, but it doesn’t seem they can fall much further. Unlike coal, there’s still a thriving demand for natural gas from many industries.

As we have said before, commodity producers can’t produce at a loss indefinitely. They will stop production in unprofitable areas, supply will go down and prices will recover. With commodities, the cure for low prices is low prices. Natural gas is no different.

One way to invest in the natural gas sector is through the United States Natural Gas Fund, an exchange-traded fund (ETF) on the New York Stock Exchange (symbol: UNG). It tracks the Henry Hub natural gas front-month futures contract on NYMEX, and is the easiest way to gain exposure to natural gas.

About Kim Iskyan

Kim Iskyan has nearly 25 years of experience as a stock analyst, hedge fund manager, political risk consultant, and financial commentator in more than half a dozen emerging and frontier markets.

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